Unmaking the engine that built America: the middle class domestic consumption market
The world’s most advanced industrialized countries, especially those in North America and Western Europe, were able to industrialize partly because they contained their own domestic markets for mass-produced goods. China, India, Africa, and Latin America in the 19th century were lands of enormous income inequality where a tiny wealthy stratum provided the only market for value-added goods. By contrast, Western European and North American countries’ relative income equality meant that they had large middle classes who were neither subsistence farmers nor victims of rural peonage. These consumers, who lived in cities and the countryside, were a market for domestic industrial (and later service) entrepreneurs, who invested in producing consumer goods (like toothpaste, automobiles, etc) that the middle class domestic consumers would purchase. This provided additional employment, raising more of the population from subsistence to consumer status, growing the size of the domestic market even while making profits for the entrepreneurs and stimulating further investment, increased industrialization, and a virtuous cycle of increasing employment, a growing middle-class, increasing consumption, and increasing investment to meet domestic market demands.
In other parts of the world, the dearth of a domestic market meant there was no field in which domestic entrepreneurs could play (in India, Africa, China, Latin America), and the tiny wealthy stratum began to direct what little demand it provided towards imported goods from the industrialized countries at the center of the world’s economy, choking off any opportunity for industrialization (only with state-led development did these countries hit upon a path–and not an unproblematic one–out of their undeveloped status: thank you Friedrich List, Gerschenkron, Gunder Frank, and Prebisch).
As technology and transportation improved (especially after World War II), and trade and international capital flows increased, the less-industrialized countries of the developing world were able to find a substitute for the domestic market to stimulate domestic investment in consumer goods production: the export market (namely, North America and Western Europe). This is why, although China has 4 times the population of the United States, it is far more dependent on US consumers for its future economic health than on Chinese consumers. There are a lot of Chinese who would like to consume, but there are still too few who can afford to do so. The United States, by contrast, has always had such a large domestic market that a slow-down in other countries’ capacity to consumer our goods has a much smaller effect on our economy’s health than vice-versa.
However, the American domestic market for consumer goods is right now facing a triplethreat that could (potentially) switch us permanently from the virtuous cycle (more consumption -> more employment -> bigger domestic market -> more growth) to a vicious cycle, which we might be seeing right now in the form of lower consumer spending -> enormous job losses.
The most obvious threat is the one that came from our unwise debt-led growth: much of our consumption in the past several years has been on credit, meaning that, unlike increased consumption from increasing incomes, it could all dry up with one little tremor of the credit markets (which is what happened this summer and fall), leading to a steep drop in consumer spending.
The second threat also has an up-side: imports. As more foreign countries depend on America’s domestic consumers as a market for their goods, a smaller share of American consumer spending goes to supporting American jobs that feed wages and salaries back into the pockets of domestic consumers. The upside of this is that American consumers get a broader choice of goods to consume, and domestic producers are forced to compete with foreign producers in price and quality of goods, or go out of business (like the Big Three auto makers). When domestic producers actually do this (instead of sticking their heads in the sand and producing cars people don’t want to buy if the price of gas goes up), then domestic producers’ goods are also highly exportable (because they are competitive with foreign goods on any consumer market in the world) which can provide American jobs. This is why the trade aspect of the threat to the cycle can be positive.
The third aspect of the threat is the most dire, however: it is the stagnation of the incomes of the middle class. Since 1980, real incomes (that is, after inflation) of the middle class in the United States have been relatively stagnant. This means that the only income-led (as opposed to debt-led) growth in the domestic consumer market comes has come from the increasing incomes of the wealthiest Americans (which have soared in the past 30 years). Under Ronald Reagan, Americans were told that somehow, if the wealthiest were made wealthier, this would help everyone, because of how much more money they would pour into the domestic consumption (and investment). However, 1% of Americans increasing their incomes by 50% does not increase consumer spending as much as 50% of Americans increasing their incomes by 1%. (For a while, as the richest Americans made a lot more money, and middle-class Americans made the same amount, there was still enormous growth in consumer spending because middle-class Americans bought on credit, but we’ve hit the end of that now.)
So what is to be done? Is there any way that policy can correct this long-term problem of the slow destruction of the middle class domestic consumption market? It is possible that there is very little that government can do. One thing that should be _un_done, however, is that the focus of tax-relief should be shifted away from the wealthiest Americans and focused on the middle class domestic consumer. Starting with Reagan and up through Bush, whenever consensus that we as a society pay too much in taxes has resulted in tax-cuts, the wealthiest Americans have succeeded in walking away with the lion’s share of the benefits from tax-cut legislation.
There are all kinds of arguments as to why that’s fair, just, or good (”they invest more in the stock market”, “they already pay a higher proportion of their income in taxes because of the progressive tax system”, “higher taxes on the wealthy dampens the incentives to innovate”), but all these theoretical, ideological, and moral justifications really come to naught when confronted with the practicalities of today’s events.
The enormous increase in incomes of the wealthiest Americans over the past 30 years (especialy rapid in the past 8 years) cannot hold up consumer spending and sustain domestic employment by itself. The only reason that these have not collapsed sooner was credit. And now credit is gone, and we appear to be on the verge of a vicious cycle that could take our economy into a state reminiscent of 19th century India or China: a tiny wealthy stratum that imports luxury consumer goods, and an enormous lower class whose decreasing consumption leads to employers shedding more jobs, which leads to even lower consumption capacity, which erodes domstic consumption and employment even more.
The lesson? Remove the moral, theoretical, and ideological reasoning from tax policy-changes: tax policy should be pragmatic. Target tax cuts to those whose share of domestic consumption needs some kind of relief in order to sustain it, not those who make so much money they’ll buy a new car with or without a tax cut. Eliminate the regressive nature of payroll taxes, and create tax credits for the lower-end of the payroll tax spectrum. And if faced with raising taxes or cutting spending on programs that help to sustain domestic consumer spending, consider raising taxes on those who will probably spend anyways, instead of forcing state, local, and federal governments to add to the tsunami of job losses that threaten the engine that built America.
And stop the conservative masquerade of people like Grover Norquist who pass of tax relief for the wealthiest Americans as “small government”. Norquist’s man in the White House over the past 8 years did not shrink government, he only accelerated the concentration of wealth that has (in the absence of credit) shrunk domestic consumption and dometic employment. If we need to cut taxes, we should always do it for the less wealthy before we do it for the more wealthy, and give the less wealthy at least as large a share of the tax cuts as we give to the more wealthy.
